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Selling Your Home Tax-Free? The Principal Residence Exemption Explained

How Canada's principal residence exemption works, when you'll owe capital gains tax, and how to calculate your tax bill when selling property.

LifeByNumbers TeamPublished on January 25, 20265 min min read

You bought your Toronto home for $400,000 in 2010. It's now worth $1.2 million. That's $800,000 in gains.

Do you owe tax on it? Maybe. Maybe not. It depends on some crucial details.

The Principal Residence Exemption (PRE)

Canada has one of the most generous home sale tax breaks in the world. If a property qualifies as your principal residence, you pay zero capital gains tax when you sell.

For that $800,000 gain? Zero tax. Completely legal.

But there are rules.

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What Qualifies as a Principal Residence?

A property qualifies if:

  1. You own it (solely or jointly)
  2. You ordinarily inhabit it (or your spouse, common-law partner, or child does)
  3. You designate it as your principal residence for those years

That third point is crucial. You can only designate ONE property per year as your principal residence (per family unit).

The "One-Plus" Formula

If you owned the home for the entire time and it was always your principal residence, the exemption covers the full gain.

But if you had multiple properties, or it wasn't always your principal residence, the formula gets complicated:

Exempt portion = (1 + years designated) / years owned × total gain

The "+1" is a gift from CRA—it gives you an extra year of exemption.

Example:

  • Owned home for 10 years
  • Designated as principal residence for 6 years
  • Total gain: $300,000
  • Exempt: (1 + 6) / 10 × $300,000 = $210,000
  • Taxable gain: $90,000

When the Exemption Doesn't Apply

1. You never lived there

  • Bought a condo, rented it out from day one, sold it 5 years later
  • Result: Full capital gains tax (50% of gain is taxable income)

2. Flipping properties

  • CRA may classify you as a business, not an investor
  • Result: 100% of profit is taxable as business income
  • This applies if flipping is your pattern or intention

3. Foreign buyers

  • Non-residents cannot claim the principal residence exemption
  • Result: Full capital gains tax plus possible withholding

4. Properties over 0.5 hectares (1.24 acres)

  • Only the first half-hectare qualifies
  • Excess land is taxable

The Cottage Problem

Many Canadians own both a home and a cottage. You can only designate one per year as your principal residence.

Scenario:

  • Toronto home: bought 2005, now worth $500,000 more
  • Muskoka cottage: bought 2015, now worth $300,000 more
  • Selling both in 2026

Strategy required:

  • Calculate gain per year for each property
  • Designate the property with higher annual gains
  • Pay tax on the other property's gain

Toronto home:

  • 21 years of ownership
  • $500,000 gain
  • Per year: $23,800

Cottage:

  • 11 years of ownership
  • $300,000 gain
  • Per year: $27,300

Optimal strategy: Designate cottage as principal residence for all 11 years, home for remaining years.

Calculating Your Tax Bill

If part of your gain is taxable:

Capital gains inclusion rate: 50% (As of 2024, this may change for gains over $250,000)

Example:

  • Taxable gain: $200,000
  • Included in income: $100,000
  • At 45% marginal rate: $45,000 tax owing

For gains over $250,000:

  • First $250,000: 50% inclusion (standard)
  • Above $250,000: 66.7% inclusion (new rate)

This change significantly affects investment properties and cottages.

The Change-of-Use Rules

What if you:

  • Lived in a home, then rented it out?
  • Rented a property, then moved into it?

Home → Rental:

  • Deemed disposition at fair market value when you start renting
  • Can elect to defer this (up to 4 years while renting)
  • Must designate it as principal residence for those years

Rental → Home:

  • Deemed disposition at FMV when you move in
  • Capital gain on rental period is taxable
  • Future gains (while living there) are exempt

The 2016 Reporting Requirement

Since 2016, you MUST report the sale of your principal residence on your tax return, even if the entire gain is exempt.

What to report:

  • Address of property
  • Date acquired
  • Proceeds of disposition
  • Years designated as principal residence

Failure to report can result in penalties and potentially losing the exemption.

Real-World Scenarios

Scenario 1: Simple case

  • Bought only home in 2015 for $500,000
  • Sold in 2026 for $900,000
  • Lived there entire time
  • Tax owing: $0 (full PRE applies)

Scenario 2: Rental period

  • Bought condo in 2018 for $400,000
  • Rented it 2018-2022
  • Moved in 2023
  • Selling in 2026 for $600,000
  • Gain: $200,000
  • Exempt (lived there 4 of 8 years): (1+4)/8 × $200,000 = $125,000
  • Taxable: $75,000
  • Tax owing (50% inclusion, 40% rate): $15,000

Scenario 3: The cottage dilemma

  • Home gain: $600,000 over 20 years ($30,000/year)
  • Cottage gain: $400,000 over 15 years ($26,700/year)
  • Designate home (higher annual gain) for all years
  • Cottage: (1+5)/15 × $400,000 = $160,000 exempt
  • Taxable: $240,000
  • Tax owing: ~$55,000-70,000 depending on inclusion rate

Planning Strategies

1. Designate strategically

  • You don't have to decide until you sell
  • Calculate which property has higher annual gains

2. Consider timing

  • If you're retiring to a lower income year, sell then
  • Lower income = lower marginal rate on gains

3. Keep records

  • Purchase documents
  • Renovation receipts (add to cost base)
  • Dates you lived in each property

4. Get professional advice

  • For complex situations (multiple properties, change of use)
  • The cost of an accountant is much less than mistakes

The Bottom Line

For most Canadians selling their only home: no tax.

For everyone else: it depends. The rules are generous but complex. The difference between understanding them and not can be tens of thousands of dollars.

Use the capital gains calculator above to estimate your tax bill. But for anything beyond a simple single-home sale, talk to a tax professional before you list.